We constantly hear the term negative gearing being thrown around in Australian politics. The Labor party have said they plan to make changes to negative gearing if they return to government, and after a period of uncertainty, the Liberal and National parties have expressed their ongoing support for retaining current negative gearing arrangements. But how does negative gearing work for Australian expats?
What Is Negative Gearing?
Negative gearing is a practice where an investor borrows money to buy an income producing investment (usually an investment property or shares), where the cost of holding or owning the investment is greater than the expected income from the investment. Negative gearing is a form of financial leverage, where the investor expects (or hopes) the growth in the value of the investment will outweigh the cost of holding or owning the investment.
Positive gearing on the other hand is where the income from an investment exceeds the cost of holding that investment.
An investment property is said to be negatively geared when the rental income from the property is less than the combined costs of holding the property. The cost of holding the property includes both cash and non-cash deductions. Cash deductions include such things as interest on loans used to purchase the house, property management fees, maintenance costs, body corporate fees, insurance, council rates etc. Non-cash deductions include such things as rental property depreciation, where you can claim a tax deduction for the loss of value of any improvements in your property.
A share portfolio is said to be negatively geared when the dividend income from the shares are less than the interest costs on a loan used to purchase the shares.
Tax treatment of negative gearing in Australia increases the attractiveness of the investment strategy as taxpayers are able to deduct the loss on holding the investment from their taxable income, and therefore also reduce their current tax liabilities.
It should be noted, according to Wikipedia, Australia is not the only country in the world to allow negative gearing. Japan and New Zealand allow negative gearing to reduce taxable income, and the USA, Germany, Sweden, and France allow losses to offset other income with some restrictions.
When Does a Negative Gearing Strategy Make Financial Sense?
Firstly, a negative gearing strategy only makes sense when you are
- able to fund from your own cash flow the annual losses in holding the investment. You should never consider borrowing to invest if you are unable to sustain your interest repayments over the longer term.
- willing to tolerate the risk of losing your initial (equity) investment, and potentially more. Borrowing to invest magnifies your gains, but also magnifies your losses. Using leverage you do risk losing more than the amount of cash you originally contributed to the investment.
Assuming you can fund the annual cash requirements of a negative gearing strategy, and are willing to accept the risk of losses, there are a number of scenarios whereby negative gearing might make sense. They include :
- If the capital gain over the holding period of the investment is greater than the accumulated cash losses during the period.
- If the income from the investment is expected to rise such that over time the cumulative income is greater than the accumulated holding costs. This would imply that the investment becomes positively geared over time. The main reason for income increasing over time would be rising rents and dividends.
- If the holding costs of the investment are expected to fall such that over time the accumuated holding costs are less than the cumulative revenue. This would imply that the investment becomes positively geared over time. The main reason for holding costs falling might be an expectation that the interest costs of holding the investment will fall over time (either due to reduced interest rates, or the loan being paid off over time).
Can Australian Expats Negatively Gear?
If you are a non-resident for tax purposes, then Australian expats can currently negatively gear property investments. What this means is that you can use any tax losses on property investments in Australia to reduce your taxable income from other Australian sourced income. If your tax losses are in excess of your Australian sourced income, these losses can be carried forward to future tax years.
To ensure you are maximising your negative gearing and tax benefits, be sure to maximise your depreciation deductions. Read more about it in my article on Rental Property Depreciation. To obtain a depreciation report for your property, I recommend using Washington Brown. You can download an application form here and obtain a $55 discount on the cost of a report.
Once you become a non-resident for tax purposes, you are no longer able to negatively gear your sharemarket investments. In fact, you are unable to deduct any costs associated with your investment in shares, but you can add these costs to the cost base of your investment to reduce your future capital gains tax liability (if applicable). If you are interested in investing in shares, I recommend you read How Australian Expats can make money on the sharemarket without paying any tax.
To understand more about the tax implications when moving abroad, download my Special Report – Tax Implications For Australians Working Abroad.
Want to take advantage of the negative gearing benefits of investing in Australian property? These articles may be of interest :
- 6 steps to buying a property while living abroad
- Should you use a Buyers Agent to buy property while living abroad?
- 8 benefits of investing in Australian property
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Disclaimer : This information is for educational purposes only and does not constitute financial or taxation advice. As this information is not advice and has been prepared without taking into account your objectives, financial situation or needs you should, before acting on this information, consider its appropriateness for your circumstances. Independent advice should be obtained from an Australian financial services licensee before making investment decisions, and a registered (tax) financial advisor/accountant in relation to taxation decisions. To the extent permitted by law, we exclude all liability for any loss or damage arising in any way.